BUSF_A01.qxd

Ratio analysis

The price/earnings (P/E) ratio can be seen as the number of years that it would

take, at the current share price and rate of earnings, for the earnings from the share to

cover the price of the share. This has been a very popular means of assessing shares.

A share with a high P/E ratio is one that has a high price compared with its recent

earnings. This implies that investors are confident of growth in future earnings. It will,

of course, be on the basis of expectations of future profits that investors will assess the

value of shares.

Dividend yield

×100%

The ratio for Jackson plc at 31 December 2008 is:

× 100 =2.2%

This ratio seeks to assess the cash return on investment earned by the shareholders.

To this extent it enables a comparison to be made with other investment opportunities

available. It is necessary to ‘gross up’ the dividend received because it is received as

if income tax at 10 per cent had been deducted before payment. Since rates of return

on investment are usually quoted in gross (pre-tax) terms, it makes for a more valid

comparison.

Whether a high or a low figure is to be preferred for dividend yield depends greatly

on the needs and investment objectives of the shareholders.

We shall take a further look at P/E and dividend yield ratios in Chapter 16.

Dividend cover

The ratio for Jackson plc for 2008 is:

=3.9 times

The dividend cover ratio indicates how comfortably the business can meet the div-

idend out of current profits. The higher the ratio, the more confident shareholders can

be that the dividend will be maintained, at least at the current level, even if there were

to be a downturn in profits.

Jackson plc’s ratios

We can now go on to assess Jackson plc through its accounting ratios. To give us a

basis for comparison we shall assess the 2008 results against those for 2007. The

income statement and balance sheet for 2007 are given in the appendix to this chapter.

The following is a table of the 2008 ratios with their 2007 counterparts.

78

20

Profit for the year

Total dividend

(20/200) ×(100/90)

5.10

Dividend per share (grossed up for tax)

Current market price per share